Magazine

All This And Icahn, Too

February 11, 2007

For almost two years running, Edward J. Zander looked like a genius. The Motorola Inc. (MOT) chief executive executed flawlessly on his strategy of cranking out "wow" products like the razr phone and delivering them via an ever-more-efficient supply chain. Then Zander ran head-on into a cell-phone price war. Suddenly the CEO, known for his morale-boosting talks, had a serious problem. Earnings plummeted by nearly half in the fourth quarter of 2006 as profit margins sank. Motorola's share price has fallen 24% since last October.

Can it get worse? Sure—Zander could have a pushy billionaire investor on his case. Here comes Carl C. Icahn, who Motorola announced on Jan. 30 has amassed 1.4% of Motorola's shares and wants a seat on its board. And Icahn isn't mincing words. He wants Motorola to spend all of its $11.2 billion stockpile to repurchase shares. "It's ludicrous that they have all this cash and don't do a buy back," he says. "That cash could be better managed by shareholders than by the company." Motorola says it is reviewing Icahn's request.

A big buyback would make many investors happy. But Icahn's arrival raises a bigger question than just one of cash management: Is Zander's strategy still workable? Many recent Motorola efforts to replace the RAZR with a hot new phone have faltered. The Rokr, a music phone that launched with Apple's iTunes a couple of years ago, failed to bowl over consumers. Nor did the pebl, a roundish flip phone, or the KRZR, a skinnier version of the RAZR from last fall. "They've had four to five duds in a row," says Citigroup (C) analyst Daryl Armstrong. "And people are not willing to give them the benefit of the doubt."

Execution has been Zander's biggest problem. Motorola lags its chief rival, Nokia Corp. (NOK), in the kind of production efficiency that leads to high margins. One former executive says Motorola is trying to be a first-rate consumer-electronics company while also outsourcing its manufacturing to third parties. That makes it difficult to manage quality because products go through multiple hands before they get to the consumer. Nokia, on the other hand, has greater control over its manufacturing. On a scale from 1 to 10, Armstrong gives Nokia a 9 in its manufacturing efficiency and Motorola a 4 or 5. That's a big reason why Motorola has overall gross profit margins of 26%, vs. Nokia's 32%.

For now, Zander is concentrating on cutting costs. In a Jan. 19 call with analysts, he said he's cutting 3,500 jobs. But Motorola also has to get a better handle on forecasting how many phones it needs to build. Parts suppliers say that working with the company is more difficult than with other manufacturers because of the volatility in product flow. One day Motorola might indicate that it needs parts for millions of units; the next day, it may cancel that particular device, according to suppliers. The uncertainty leads to a greater chance of defects and missed deadlines in a product launch, analysts say.

Icahn only increases the pressure to fix those problems. When he doesn't get his way he has been known to threaten a proxy fight, as happened at Time Warner Inc. (TWX), and push for a breakup. Icahn says that isn't his plan for now, but added: "We may focus on stuff like that on another date."

In the event of a breakup, Zander may be forced to consider jettisoning his networks business. That unit specializes in wireless broadband gear for emerging technologies such as WiMAX, and Zander considers it a key to future growth. But Motorola has left itself vulnerable by focusing largely on radio frequency technology, which several companies offer, while rivals such as Alcatel-Lucent (ALU) and Nokia have built a capability in more proprietary switching technologies that are in demand by wireless carriers.

Still, many investors would cringe if Motorola had to get rid of a business that is so tightly integrated with its bread-and-butter mobile-devices business, says Lawrence Harris, an analyst with Oppenheimer & Co. (OPY)And that may be one reason for Icahn to move cautiously. "He's brought up a very reasonable question of strategy," says Henry Asher, president of Northstar Group Inc. in Manhattan, which owns a small stake in Motorola. "It begins a dialogue."